The areas of shareholder rights and shareholder voting are fundamental features of a sound corporate governance system. The Organisation for Economic Co-Operation and Development (OECD) Principles of Corporate Governance (2004) state that ‘the corporate governance framework should protect and facilitate the exercise of shareholders’ rights’ and amongst these shareholder rights are the right to relevant, timely and regular information about the company; the right to participate and vote in shareholder meetings; the right to elect and remove members of the board; and the right to share in the company’s profits. Shareholders are the providers of risk capital and as such they need to be able to protect their investment by ensuring that a competent board is in place to manage the company and to ensure that effective strategies are in place for the company’s overall corporate performance and long-term sustainability.
The International Corporate Governance Network (ICGN) issued its revised Global Corporate Governance Principles (2009a) and one of the principles, Principle 8, relates to Shareholder Rights. Principle 8 includes accountability of the board to shareholders; shareholder protection whereby boards ‘treat all the company’s shareholders equitably and should respect and not prejudice the rights of all investors. Boards should do their utmost to enable shareholders to exercise their rights, especially the right to vote, and should not impose unnecessary hurdles’; voting-related rights whereby the exercise of ownership rights by all shareholders should be facilitated; and shareholder rights of action such that shareholders who are treated inequitably have rights of redress, for example, minority shareholders who find themselves subject to abusive or oppressive conduct should be able to find redress for this.
The shareholders’ rights outlined above are clearly seen as fundamental to the shareholder-company relationship. Directors are in a position of trust and should manage the company in such a way as to generate long term sustainable value whilst also taking into consideration their relationships with wider stakeholder groups including employees, customers, suppliers and the wider community on which their activities have an impact. Shareholders’ rights include, as we have seen above, shareholder voting which is an important tool as it can be used to elect directors, to approve the annual report and accounts and so on. In the context of shareholders’ voting at general meetings in the Netherlands, de Jong et al. (2006) describe the various areas that may be decided upon at a company’s general meeting. These include adoption of the annual accounts by the general meeting (which may, depending on the country, imply a discharge of management board members and supervisory board members from liability for the performance of their duties); distribution of profits; issue of shares and pre-emptive rights; share repurchase; amendment to articles of association; reduction of share capital; appointment of external accountant/auditor; remuneration of board members; appointment and dismissal of board members; and takeover defences.
Gillan and Starks (2007) place shareholder activism on a continuum of reactions that unhappy shareholders can give to corporate governance concerns. On the one side, shareholders can sell their shares (i.e., vote with their feet), while at the other extreme of the continuum is the market for corporate control, where investors start takeovers to bring about corporate changes. The role of shareholder activism arises when shareholders decide to hold their shares and try to induce changes within the company without a change in its control. These investors may then press for corporate reforms by negotiating with senior management (or the board of directors) behind the scenes, or—especially when the former is unresponsive—by submitting proposals for shareholder vote.
The shareholder vote is increasingly considered as one of the most powerful means that institutional investors have to engage with the boards of directors of their investee companies (see e.g., Bebchuk 2005; Mallin, this issue). Previous empirical studies found that shareholders do exert pressures on boards of directors even when their vote at the shareholders’ meeting is not legally binding, because proposals that win a majority vote end up being implemented by the board of directors in many cases (Bizjak and Marquette 1998; Martin and Thomas 1999; Thomas and Cotter 2007; Ferri and Sandino 2009; Ertimur et al. 2010), with relevant spillover effects even on non-target companies (Ferri and Sandino 2009). Boards of directors that choose to ignore the shareholder vote have been shown to draw negative press and receive downgrades by governance rating firms. In the US such directors become less likely to be re-elected and more likely to lose other directorships (Ertimur et al. 2010). Hence shareholder proposals appear to have an emerging role in reducing agency costs by increasing director responsiveness to shareholder concerns (Thomas and Cotter 2007).
As well as shareholder voting, institutional shareholders have other means at their disposal to engage with the board. These include constructive dialogue with companies, usually in the form of regular face-to-face meetings but also via other means such as telephone conversations (Logsdon and Van Buren III 2009). For example, Brav et al. (2008) report that US-based hedge fund activists adopt a wide variety of tactics to pursue their aims, from friendly interactions with senior management to being openly confrontational with target boards of directors. Melis et al. (2010) provide evidence that minority shareholders can successfully exert an influence on executive remuneration design when they are able to appoint a director to the board.
Various studies have shown that there is a link between shareholder rights and corporate performance, in the sense that being able to exercise shareholder voting rights, or engage with companies via dialogue or other means such as focus lists, has a positive effect on corporate performance. Gompers et al. (2003) examined the ways in which shareholder rights vary across firms. They constructed a ‘Governance Index’ to proxy for the level of shareholder rights in approximately 1,500 large firms during the 1990s. An investment strategy that bought firms in the lowest decile of the index (strongest rights) and sold firms in the highest decile of the index (weakest rights) would have earned abnormal returns of 8.5 percent per year during the sample period. They found that firms with stronger shareholder rights had higher firm value, higher profits, higher sales growth, lower capital expenditures, and made fewer corporate acquisitions.
In situations where directors are not responsive to dialogue with institutional shareholders, then investor activism may include putting the company on a focus list such as those operated by the California Public Employees Retirement System (CalPERS). Corporate performance is often shown to improve after such engagement, for example, studies such as those carried out by Nesbitt (1994) have reported positive long-term stock price returns to firms targeted by CalPERS. Nesbitt’s later studies show similar findings. Brav et al. (2008) describe various objectives of hedge funds’ activism (e.g., changes to company capital structure, altering company business strategy, seeking a sale of the target company, and making improvements to its corporate governance) and found that target companies experience increases in returns on assets, operating profit margins, and total payout yields.
The effectiveness of engagement is also highlighted by the study carried out by Becht et al. (2009). The researchers were given unlimited access to Hermes’ resources such as reports, transcripts of telephone conversations and so on which documented the work with the companies in which Hermes’ UK Focus Fund invested over the 1998–2004. They reviewed all forms of public and private engagement with 41 companies. They found that when the engagement objectives led to actual outcomes, there were economically large and statistically significant positive abnormal returns around the announcement date. On the basis of their findings they concluded that shareholder activism can produce corporate governance changes that generate significant returns for shareholders.
Finally, the global financial crisis has once again highlighted the importance of corporate governance in restoring trust in global capital markets. The ICGN (2009b) statement emphasized ‘…securing and maintaining the rights of shareholders and developing the transparency needed for them to exercise these rights in a responsible, informed, and considered way’. Ultimately it is only with shareholders exercising their protected rights and engaging with companies that overall risks can be mitigated and long term sustainable corporate performance achieved.
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